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What Impact Does Debt Consolidation Have on Your Credit Score?

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Debt consolidation is easily one of the most popular methods of getting back control over your finances when you have become trapped in debt. Simple in its concept, debt consolidation can usually be done by yourself and when carried to its logical conclusion with discipline can make you debt-free in a relatively short period of time. There are multiple benefits of debt consolidation. The first obvious advantage is that you no longer have to juggle multiple debts and pay by dates. You can also significantly lower your interest expense and pay off your debt faster by identifying a lender offering a relatively lower rate of interest compared to the steep APRs of your credit cards. Additionally, debt consolidation helps you to repair your damaged credit score helping you to access finance in the future more easily.

How Does Consolidating Debt Assist in Boosting Your Credit Score?

Become easier to pay by the due date: When you undertake debt consolidation, you no longer have to bother about keeping track of the statements of multiple credit cards and remembering to make the minimum due payments by the different due dates. With every payment that you miss making on time, not only do you get a hefty late payment fee slapped on by the card issuer but also your credit score takes a hit. After consolidating debt, you are left with only one loan to manage and one payment to make every month. This automatically lowers the chance of your missing out on making the payment. By maintaining a clean repayment record over the tenor of the consolidation loan, your credit history gets cleaned up and your credit score gets a boost. According to https://www.forbes.com, as much as 35% of your credit score is based on your payment history, which is nothing but how regularly you pay your dues.

The credit utilization ratio decreases: When you consolidate your debt and take on a fresh consolidation loan, you can pay off the credit card balances that were causing you to lose your sleep. When you repay all your credit cards, the credit utilization ratio across all the cards becomes nil and serves to boost your credit score because it sends out a signal that your finances are so stable that you do not need to use credit card debt to finance your lifestyle. Even if you do not qualify for a large loan to wipe off the entire debt, reducing the balance of the cards with the highest APRs will still improve your credit utilization ratio. If you take care to reduce these balances to less than 30% of the credit limits of your cards, you will benefit the most as the credit bureaus interpret it as a sign of stable financial health. Since the FICO score has a 30% weight to credit utilization, reducing the card balances can give a significant boost to your credit score.

Budgeting becomes easier: With multiple credit cards all carrying different balances, it becomes a very difficult task to monitor the different due payments every month and to actually make the payments by the different due dates. Apart from the chances of you missing a due date, it may also happen that you may not have sufficient cash to make all the payments every month. When you consolidate your credit cards using a debt consolidation loan from a bank or a private lender, the due date is constant as is the amount of the repayment because both the rate of interest and the loan period are fixed. Look at debt consolidation ratings online to make an informed choice on which debt consolidation company to use. When you know exactly the amount of money you have to set aside every month for the loan repayment, the budgeting of household expenses automatically become easier and you can manage your finances better.

Settle delinquent debts: Apart from using the proceeds of the debt consolidation loan to pay off your credit card balances, you can also use the money to pay off just about every type of loan you have, personal loans, consumer loans, medical bills, payday loans, utility bills, student loans, unpaid taxes as well as debts that have become delinquent and have been sent for collection by the creditors. Delinquent debts can have a severe impact on the credit score with credit bureaus factoring in the age, the amount, and the number of delinquencies in the final credit score calculation. By using the consolidation loan to pay off delinquent debt, you will immediately benefit by a credit score boost and also get relief from the calls of debt collection agents.

Credit file diversification:

Taking on a debt consolidation loan acts to add diversity to your mix of credit especially if your debts are overwhelmingly due to unpaid credit card balances. The debt consolidation loan will add an installment account to your mix of credit that is interpreted positively by FICO. Most people are unaware that a diversified credit mix is given a 10 percent weight by FICO, which is why you should always try to have a mix of installment accounts like personal loans and revolving credit like credit card dues. All extra debt exposure negatively acts on your credit score; however, an installment account will have a lesser impact than revolving debt.

How You Can Damage Your Credit with Debt Consolidation

Initial negative impact: when you apply for a debt consolidation loan, the lender will pull your credit report, which acts to damage your credit score. However, when you use the loan to improve your credit utilization ratio, the credit score automatically receives a boost. Getting yourself prequalified for the loan will help you to shop around for the best terms and avoid multiple hard inquiries on your credit report.

Easier to acquire more debt: Freeing up your credit cards can have a dangerous consequence if you are not able to change your free-spending ways and continue to charge your cards just like before. Sooner or later, you will again have accumulated a lot of debt on your credit cards as well as have a debt consolidation loan to worry about.

Conclusion

Debt consolidation is extremely useful for getting on top of your debt. When you manage to put your finances together, your credit score will see an improvement and over time using judicious budgeting and a conservative lifestyle, you can ensure that your credit score is repaired giving you the freedom of unrestricted financial choices.

 

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